Working Capital’s Blind Spot in India’s Credit System

Working capital is meant to fund the ordinary pulse of a business — stock on shelves, goods in transit, invoices waiting to be paid, suppliers waiting to be settled. In theory, it is about financing the operating cycle. In practice, it has become an exercise in sanctioned bank limits, drawing power and compliance paperwork.

For all the forms, ratios and projections involved, India’s working-capital system continues to miss what most businesses actually run on: trade credit. The credit a supplier extends when goods are shipped. The time a buyer takes to settle an invoice. The gap between the two. These are the mechanics of commerce, yet they remain peripheral in formal appraisal.

Most working-capital assessments still begin from the bank’s side of the balance sheet. Ratios are examined, statements are certified, collateral is evaluated. Yet the underlying trade dynamics — who buys from whom, on what terms, and how reliably payments are made — are often treated as secondary.

The irony is that for most firms, especially MSMEs, supplier credit is not a supplementary cushion. It is the primary source of operating liquidity. Businesses first expand purchases on credit, then extend credit to customers, and only approach banks when this growing trade cycle strains internal resources. Bank working capital is therefore derived demand. It follows trade credit expansion rather than initiating it.

But appraisal systems rarely reflect that reality.

Trade Credit
Financials compiled by the Reserve Bank of India across nearly four decades and 2.38 million company-years show sundry creditors running at around 16–17% of sales — consistently higher than bank working capital, which sits at roughly 8–14%. Among 24 manufacturing companies in the Nifty 50, the contrast is even starker: trade credit at about 19% of sales against bank working capital at just 3%.

 Corporate Data Points (FY1985–2023) – Average Sales, Number of Companies, and Working Capital Ratios

 

A separate RBI study found that in the early 2000s, trade liabilities accounted for roughly 19–24% of total liabilities for large public companies, while bank credit stood at only 11–14%. Trade credit is not mainly an MSME phenomenon. It is the dominant liquidity channel across the corporate spectrum.

Yet appraisal frameworks continue to focus primarily on bank exposure, profitability ratios and net worth. The inter-firm credit network, the system through which liquidity actually circulates, sits in the background.

There is also an informational dimension that is routinely ignored. When suppliers are willing to extend credit, they are implicitly signalling confidence in a buyer’s reliability. That is decentralised credit assessment at work. But banks seldom anchor their analysis in these signals. Trade payables and receivables are treated as static line items rather than behavioural indicators.

This oversight is not new. India’s commercial history offers examples of robust trust-based credit networks, particularly among traditional trading communities. Long before formal banking deepened, inter-firm credit moved capital across regions and sectors. Payment discipline and reputation substituted for collateral.

Modern banking has formalised credit, but it has not fully absorbed the intelligence embedded in those trade relationships.

The macro consequences are visible. India’s credit-to-GDP ratio remains modest compared with many peers. At the same time, studies repeatedly point to unmet formal credit demand among MSMEs and supply-chain firms, even as banks invest heavily in government securities. The issue is not merely the volume of credit, but how credit demand is interpreted.

When the dominant liquidity channel is under-analysed, bank working-capital growth naturally lags real economic activity. 

Backward Metrics
Working-capital assessment also suffers from time distortion. Financial statements are often six to twelve months old. Receivables appear as book figures even though many invoices are paid late. Operating cycles are assumed from industry norms rather than borrower-specific buyer behaviour.

Risk pricing remains largely collateral-centric. Cash-flow conduct is estimated, not observed.

The outcome is predictable. Limits are sometimes inadequate, creating operational stress. At other times they are excessive, increasing diversion risk. Disputes over drawing power recur. Monitoring becomes procedural rather than insightful.

Compounding this is limited integration of verified transaction-level data. GST filings and bank statements are increasingly reviewed, but they are not synthesised into live, cycle-based measures of trade flows. Borrower-declared figures for debtors, creditors and inventory still carry significant weight.

That leaves room for distortion.

Opacity has also fuelled fraud. Inflated receivables, circular trading and evergreening become easier when reliance rests on declarations and periodic audits. The RBI has noted long detection lags in major frauds, particularly in advances. Receivables and inventory are easier to manipulate than fixed assets, and static oversight struggles to keep pace with dynamic trade activity.

Regulators have not been passive. Committees have been formed and guidelines issued. Yet operational complexity persists. Inventory moves daily. Receivables age differently across buyers. Related-party exposures evolve. Monitoring becomes document-heavy and time-intensive, often encouraging form over substance.

The deeper issue is visibility. What lenders ultimately need is not more paper, but behavioural intelligence. How much does a firm actually sell? Who are its buyers? Do they pay on time? Are payment cycles stretching?

That information sits in invoices and payments.

India already has much of the necessary infrastructure. GST captures invoice-level B2B data. Digital payment systems generate timestamped transaction trails. What is missing is systematic pairing — securely linking invoices to actual payments to trace transactions through their life cycle.

Such linkage would allow receivable cycles to be computed from evidence rather than assumption. Limits could align with verified turnover and collection behaviour. Payment delays could serve as early warning signals.

Working capital does not fail because banks lack models. It falters because they lack real-time visibility into trade conduct. Until appraisal frameworks integrate the trade credit core, WC finance will continue to address symptoms — loan demand — rather than drivers — the health of inter-firm liquidity.

Visibility, more than volume, may be the true reform India’s credit system requires.

This is Part 1 of a two-part series on working capital. The second part will examine why digitisation of India’s working capital is still stuck on the papers.